Question

Explain how changes in wealth, the price level, interest rates, and expectations alter the consumption curve.

Pick an example of one of the changes above and explain what happens. For example, if you were to suddenly inherit some money (increased wealth), how would that affect your consumption curve?

Answer 1

The consumption curve seen in the framework of income-consumption shifts upward as the household wealth raises. When there is an increase in the overall price level, the curve shifts downwards, an increase in interest rate increases the opportunity cost of consumption, which shifts the curve downwards and and expectations of increased interest rate in future increases current consumption since borrowing is cheaper now and that shifts the curve upwards.

If one were to suddenly inherit some wealth, that would shift the consumption curve upwards as shown in the figure. More amount of each (normal) good will be consumed at the new consumption curve. The two axes correspond to the goods X1 and X2 while C1 and C2 are the consumption curves.

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